Question

Xavier Manafacturing and Zulu Products each seek funding at the lowest possible cost. Xavier would prefer the flexibility of floating rate borrowing. Xavier is the more credit worth company. They face the following rate structure. Xavier, with the better credit, has lower borrowing costs in both types of borrowing:

Xavier

Credit Rating : AAA

Fixed rate cost of borrowing : 8%

Floating rate cost of borrowing: LIBOR +1%

Zulu

Credit Rating : BBB

Fixed rate cost of borrowing : 12%

Floating rate cost of borrowing: LIBOR +2%

Xavier wants floating rate debt, so it could borrow at LIBOR +1%. Zulu wants fixed rate, so it could borrow fixed at 12%. However, it could borrow floating at LIBOR +2% and swap for fixed rate debt. What could each company do?